When there is an economic disequilibrium between the spouses after a divorce, it is common to set a compensatory pension. But what few people know is that the tax treatment can make a big difference.
How is it actually taxed?
Provided that the pension is ordered or ratified by a judge, the treatment in personal income tax is as follows:
- The payer can reduce their taxable income by the amount paid.
- The beneficiary must declare it as income from work.
However, do not confuse this pension with the pension in favour of the child, which is exempt from income tax. In this case, the payer cannot deduct anything, although the law allows them to apply the tax scale separately to soften the progressivity of the Personal Income Tax.
Furthermore, until recently, the tax authorities understood that the reduction could not be applied until the regulatory agreement had been ratified by the courts. This meant that previous payments were not considered for tax purposes.
However, the Supreme Court has changed the rules: now the reduction is valid from the moment the regulatory agreement is signed, provided that the subsequent ratification does not modify what has been agreed. This is an important victory for taxpayers.
Pay all at once or little by little?
The pension can be paid in periodic instalments or in a single payment, even with the transfer of an asset. However, there is a problem with the single payment:
- The deductible pension cannot exceed the total taxable income for the year.
- Any amount exceeding this limit is lost and cannot be applied in future years.
Therefore, paying everything at once may seem practical, but from a tax perspective it is a costly mistake. It is usually more profitable to spread out the payments:
- All amounts will be deductible.
- And by reducing the highest taxed income each year, the tax savings will be greater.
Payment with assets: the risk of paying with your home.
Another option is payment with assets, which is very common through the transfer of 50% of the main home. But beware: this can be a hidden tax trap.
- The payer must declare a capital gain on the revaluation of their share of the property. They are only exempt if they apply the exemption for reinvestment in another main home.
- Furthermore, if the value of that half exceeds the taxable base for the year, the excess is lost permanently.
In short: paying with assets or in a single payment may sound liberating, but the tax authorities always get their share.
How to plan before the Spanish Tax Authorities: the smart alternative
If you are the paying spouse, there is a perfectly valid legal strategy for paying the compensatory pension without losing deductions.
Instead of handing over your share of the property directly, do the following:
- Dissolve the joint ownership and award your 50% share of the house to your ex spouse but agree that the price of that half will be paid to you over several years.
- At the same time, agree a compensatory pension in cash for the same amount, also divided into the same instalments.
- Each year, offset both payments in writing.
In this way, the payment with assets is transformed, for tax purposes, into a deductible instalment payment, allowing you to maximise your income tax savings and avoid the tax burden of a single payment.
In short: it is not a question of avoidance, but of better planning. The tax authorities play by the rules, but you can too.
